Elasticity of Supply and Elasticity of Supply and DemandDemand

Elasticity and InelasticityElasticity and Inelasticity

Price elasticity of demand is the response Price elasticity of demand is the response of quantity demanded to a change in price of quantity demanded to a change in price (elasticity measures responsiveness).(elasticity measures responsiveness).– Price change is a stimulusPrice change is a stimulus

Bounces a lot= elasticBounces a lot= elastic Does not bounce much= inelasticDoes not bounce much= inelastic

Qualities that Affect Elasticity of Qualities that Affect Elasticity of DemandDemand

SubstitutabilitySubstitutability Proportion of income spent on productProportion of income spent on product

Luxury or necessityLuxury or necessity

Is it habit-forming?Is it habit-forming?

TimeTime

Elasticity CoefficientsElasticity Coefficients

eed= % change in quantity demanded/% change in priced= % change in quantity demanded/% change in price

Midpoint or Arc Method: Midpoint or Arc Method: eed=d=– ∆∆Q/((Q+Q1)/2)Q/((Q+Q1)/2)– ∆∆P/((P+P1)/2)P/((P+P1)/2)

What the coefficients mean:What the coefficients mean:

– eed > 1 Elasticd > 1 Elastic

– eed < 1 Inelasticd < 1 Inelastic

– eed = 1 Unit elasticd = 1 Unit elastic

Income Elasticity of DemandIncome Elasticity of Demand

eed= % change in quantity demanded/% change d= % change in quantity demanded/% change in incomein income– In measures of elasticity, if income and quantity In measures of elasticity, if income and quantity

move in the opposite direction- that is, if one move in the opposite direction- that is, if one increases while the other decreases- then the increases while the other decreases- then the elasticity coefficient will be (positive/negative?)elasticity coefficient will be (positive/negative?)

– Remember that if income increases, the demand Remember that if income increases, the demand for a normal good increases and demand for an for a normal good increases and demand for an inferior good decreases. If the good is a normal inferior good decreases. If the good is a normal good, income elasticity will be good, income elasticity will be (negative/positive?) If it is an inferior good, (negative/positive?) If it is an inferior good, income elasticity will be (negative/positive?)income elasticity will be (negative/positive?)

Total RevenueTotal Revenue Because the relationship between price and Because the relationship between price and

quantity demanded is inverse, a total revenue quantity demanded is inverse, a total revenue test can be used to determine the price elasticity test can be used to determine the price elasticity of demand:of demand:

– Price x quantity=total revenuePrice x quantity=total revenue A) If total revenue moves in the same direction as A) If total revenue moves in the same direction as

price, demand is price inelastic.price, demand is price inelastic. B) If total revenue moves in the same direction B) If total revenue moves in the same direction

as quantity or inversely to price, demand is price as quantity or inversely to price, demand is price elastic.elastic.

C) If total revenue remains the same as price C) If total revenue remains the same as price increases, demand is unit elastic.increases, demand is unit elastic.

Who Really Pays the Tax?Who Really Pays the Tax? Often the person who actually pays the Often the person who actually pays the

government does not always bear the burden of government does not always bear the burden of the tax. The person who bears the burden of the the tax. The person who bears the burden of the tax is said to bear the tax is said to bear the incidenceincidence of the tax. of the tax.

Taxpayers will shift the incidence of the tax Taxpayers will shift the incidence of the tax whenever possible.whenever possible.

The incidence of tax can be shifted only when the The incidence of tax can be shifted only when the taxpayer can get a higher price for something he taxpayer can get a higher price for something he or she sells or a lower price of something he or or she sells or a lower price of something he or she buys, the tax is shifted backward.she buys, the tax is shifted backward.

How much of the incidence of a tax can be shifted How much of the incidence of a tax can be shifted depends on the elasticity of the supply and depends on the elasticity of the supply and demand curves. The incidence is heaviest on the demand curves. The incidence is heaviest on the most inelastic curve.most inelastic curve.